Managers believe private equity has a positive outlook

Strong realisations likely to fuel further growth in the private equity sector as managers claim that the sector is more disciplined following the recession.

The recession and credit crunch took its toll on private equity investment companies, however, owing to recent strong performance, the private equity sector has bounced back. With the popularity of private equity investment companies seemingly on a steady rise, the Association of Investment Companies (AIC) has canvassed the opinions of managers to discuss the prospects for the sector in 2011.

Increasing value in underlying portfolios has contributed to a lift in the share price of many private equity companies; the average private equity investment company is up 23% over the last year, compared to a 12% rise in share price for the average investment company.

‘Listed private equity has enjoyed a return to favour of late, and is likely to continue to do well through 2011,’ said Alex Barr, manager of the Aberdeen Private Equity Fund Limited.

‘Investors are returning based on increased optimism for private equity fundamentals and encouraged that many quoted private equity funds are seeking to address liquidity issues. Increased levels of M&A are providing a better exit environment and lifting valuations at which unrealised companies are being held in portfolios,’ he added.

Peter McKellar, manager of Standard Life European Private Equity Trust described the outlook as largely positive, given an expected narrowing of share price discounts to NAV and increasing valuations. ‘Those increasing valuations should be underpinned by solid earnings growth at underlying investee companies, particularly those based in northern Europe,’ he explained.

Emma Osborne, head of Fund Investment at Graphite Capital Management emphasised the value which could be released from underlying assets. ‘With many private equity managers preparing for fund raisings in the next 12 to 24 months, they will be looking to achieve strong exits from their current portfolios. This is likely to drive both higher realisation proceeds than last year and NAV growth, as sales still tend to be at good premiums to holding values,’ she said.

The turbulence of the recent financial crisis has created some opportunities for managers of private equity investment companies, according to Tim Levett, chairman of NVM, managers of Northern Investors. ‘The opportunity for the sector is to invest at the right point in the cycle to take advantage of the recovery when it comes. Changes to Capital Gains Tax and generally brighter prospects are encouraging more owner-managers to consider selling their business to their managers. We are currently seeing good opportunities at realistic prices,’ he said.

The recession, he added, has influenced his view on potential investments. ‘We are much less inclined to take on board significant bank debt in our investments. Whilst banks are continuing to lend, the level of funding available for smaller companies has reduced over the past three or so years. This has created a gap that is being filled by private equity funds.  Whilst most private equity investment has been in highly leveraged buy outs, we have never relied on large debt multiples to drive our returns,’ he added.

Despite the optimism currently surrounding the sector, managers warn not to get too bullish.
Caution is the order of the day, according to Barr. ‘Exuberance may be the principle risk and we would not welcome a rapid return to premium valuations, though we feel this is unlikely to happen for some time. Likewise we need pricing and leverage discipline from large buyout houses who bear a significant amount of responsibility for the damaged private equity environment from which investors have only just returned,’ he said.